A Critical Look at the Performance of the Federal Reserve

The Federal Reserve has largely been a failure and it is time to replace it.  That is the conclusion of a November/December 2012 Policy Report by the Cato Institute.  Here is how they characterized the aim of their report:

In the aftermath of the Panic of 1907, Congress appointed a National Monetary Commission. In 1910 the Commission published a shelf-full of studies evaluating the problems of the postbellum National Banking system and exploring alternative regimes. A few years later Congress passed the Federal Reserve Act.

Today, in the aftermath of the Panic of 2007, and as the one hundredth birthday of the Federal Reserve System approaches, it seems appropriate to once again take stock of our monetary system. Has our experiment with the Federal Reserve been a success or a failure? Does the Fed’s track record during its history merit celebration, or should Congress consider replacing it with something else? Is it time for a new National Monetary Commission?

We address these questions by surveying relevant research. The broad conclusions we reach based upon that research are that the full Fed period has been characterized by more, rather than fewer, symptoms of monetary and macroeconomic instability than the decades leading to the Fed’s establishment; while the Fed’s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its (undoubtedly flawed) predecessor; and alternative arrangements exist that might do better than the presently constituted Fed has done.

These findings do not prove that any particular alternative to the Fed would, in fact, have delivered superior outcomes: to reach such a conclusion would require a counterfactual exercise too ambitious to fall within the scope of what is intended as a preliminary survey. The findings do, however, suggest that the need for a systematic exploration of alternatives to the established monetary system, involving the necessary counterfactual exercises, is no less pressing today than it was a century ago.

Here is their conclusion:

Available research does not support the view that the Federal Reserve System has lived up to its original promise. Early in its career, it presided over both the most severe inflation and the most severe (demand induced) deflations in post—Civil War U.S. history. Since then, it has tended to err on the side of inflation, allowing the purchasing power of the U.S. dollar to deteriorate considerably. That deterioration has not been compensated for by enhanced stability of real output.

Although some early studies suggested otherwise, recent work suggests that there has been no substantial overall improvement in the volatility of real output since the end of World War II compared to before World War I. While a genuine improvement did occur during the subperiod known as the “Great Moderation,” that improvement, besides having been temporary, appears to have been due mainly to factors other than improved monetary policy. Finally, the Fed cannot be credited with having reduced the frequency of banking panics or with having wielded its last-resort lending powers responsibly. In short, the Federal Reserve System, as presently constituted, is no more worthy of being regarded as the last word in monetary management than the National Currency System it replaced almost a century ago.

3 thoughts on “A Critical Look at the Performance of the Federal Reserve

  1. in addition, the Fed is monetizing the debt with magic money. When hyper-inflation hits, the interest rates will go up accordingly. My understanding is that the private Fed which has invested nothhing of it’s own will collect those giant interest payments on our debts making it all the harder to pay off the debt.

  2. The Fed. and the Congress of late have been our biggest enemy, our most dangerous. It appears the Fed. has been politicised, so that it now serves as an arm of the Dem/Prog party of borrow and spend. Whatever stupid phrase they use, the Fed. is now monetizing the debt in giant blobs. Certainly our next bubble will be when the “monetary Bubble” bursts. It will be one of our worst.

    Maybe Martins “all but 2%” will also be gone, and our childrens allowance might pay off the National Debt?

    We must do better, both than the Fed, and better than this crusty, useless Congress

  3. I would challenge the use of the verb “allow” regarding the Fed’s damage to the purchasing power of the dollar, 1913-to-present: the verb “cause” is more accurate. Pre-Fed, the dollar declined about 12% over 124 years. Since 1913, the entity specifically charged “to regulate the value thereof” [money] has by deliberate action destroyed all but 2%. As FDR said, “nothing in politicsd happens by accident.”

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